A Case for Buy and Hold: S&P 500 Long Term Trends

At yesterday's Power Lunch town hall (links to video highlights are below), there was some good debate on whether buy and hold pays off in the long run. During one segment, Dennis Kneale went back in time to show that while the market is down in the short term, the S&P 500 Total Return has yielded a compound annual return of over 8% per year since 1988. Others argued that even with a long term horizon, there are plays you can make to help you outperform, especially in these volatile times.

Here are some of the analyses that fueled the discussion:

1) Short vs. Long Term Trends: Over the past decade we have seen some significant swings in the markets with no more than five years between peaks and troughs but over the long run, the trend has been fairly steady.

First the shorter term results...

The S&P 500 Total Return index (accounts for price appreciation and dividends) peaked at 2447.03 on October 9, 2007. Since then, it is down 45%.

From its peak to its trough of 1206.04 on 11/20/2008, it fell at a Compound Annual Growth Rate (CAGR) of -47.0%.

$100 invested on 10/9/07 was worth $49.29 on 11/20/2008

Conversely, from its trough of 1108.91 on 10/9/2002 to its peak of 2447.03 on 10/9/2007 the S&P Total Return gained a total of 121%

CAGR of +17.2% (CAGR of +1.4% from 2002 trough to 2008 trough)

$100 invested on 10/9/02 was worth $220.67 on 10/9/2007

From its peak of 2107.28 on 3/24/2000 to its trough of 1108.91 on 10/9/2002 the S&P Total Return lost 47%

CAGR of -22.3.0% (CAGR of -6.2% from 2000 peak to 2008 trough)

$100 invested on 3/24/00 was worth $52.62 on 10/9/2002

Now look at the long term (see chart below). Extending the trend line from its divergence point in 1995, you can see that while we have fallen significantly from the highs of late 2007, we are exactly on trend. Many technicians will tell you that a buying opportunity occurs when a security dips to its trend line and bounces back up. Unfortunately, that does not mean that a person who is nearing retirement has the luxury of recouping the significant losses he or she may have just experienced, but if you are further away from retirement, it could be the time to start getting your feet wet. Since 1995, the CAGR for the S&P Total Return Index is over 6%; since 1988, it is over 8%.

Continue to the next page to see what would have happened if you panicked and got out of the market at the bottom, i.e., "sold low."

Risk of Missing the Bounce from the Bottom

2) Risk of Missing the Bounce from the Bottom

We looked at the most recent bear markets, defined as 20+ percent drops from peak to trough, to see if there are any lessons to be learned from their respective recoveries. The examples show that when the bottom comes, the market has the bulk of its gains in the first few days of recovery.

Bear Market Example I - Peak: March 19, 2002, Trough: October 9, 2002

From its trough on 10/9/02, it took 27 days (20 trading sessions) for the Dow to post a 20% gain

Within the first eight trading sessions of reaching a bottom, the Dow posted 86% of the gains it achieved in the entire 27-day period

If you were out of the market for the top five days during that period, you would have been down 10% after the first eight trading sessions instead of up

If you bought at the bottom and held for the entire 27-day period, but missed the top five days, you would have made 3% instead of 20%

From its trough on 9/21/01, it took 58 days (41 trading sessions) for the Dow to post a 20% gain

Within the first seventeen trading sessions of reaching a bottom, the Dow posted 67% of the gains it achieved in the entire 58-day period. (After eight trading sessions the Dow had already posted 52% of the gains)

If you were out of the market for the top five days during that period, you would have been up 24% after seventeen trading sessions from the trough.

If you bought at the bottom and held for the entire 58-day period, but missed the top five days, you would have made 7% instead of 20%.

So looking at these examples, are there any stocks or sectors that outperform in the recovery?

Which Stocks Win Coming Off the Bottom?

3) Winners and Losers Coming Out of the Last Bear Markets: Extending the analyses on the previous bear markets, we decided to look at which S&P sectors and stocks outperformed their peers as the markets recovered.

Bear Market I - Bottom on 10/9/2002

Top 20 S&P Stocks up the most 1 year after reaching a market bottom

55% were in the Information Technology Sector

10% each were in the Utility, Energy, and Material Sector

5% each were in the Telecommunication, Consumer Discretionary, and Industrial Sector

Bottom 20 performers in the S&P 1 year after reaching a market bottom

30% were in the Healthcare Sector

25% were in the Consumer Staples Sector

15% were in the Consumer Discretionary Sector

Bear Market II - Bottom on 9/21/2001

Top 20 S&P Stocks up the most 1 year after reaching a market bottom

60% in the Consumer Discretionary Sector

15% in the Information Technology Sector

10% each in the Material and Industrial Sector

5% in the Health Care Sector

Bottom 20 performers in the S&P 1 year after reaching a market bottom

40% in the Information Technology Sector

25% in the Utilities Sector

15% in the Energy Sector

10% each in Telecommunication Sector

5% each in the Health Care and Industrial Sector

Looking back even further at the next two bear markets, the story is similar. Consumer Discretionary and Technology stocks are amongst the top performers as businesses and consumers begin to purchase items they had deferred for the down cycle.

Note that while the sectors are similar from recovery to recovery, some of the companies that were winners out of one downturn were losers in another. So, as always, make sure to do your homework.